Preferred Stock

Welcome to Rockydennis Presents Preferred Stock, a laymen’s explanation of preferred stock. Continue with us on this journey of learning and discovery!

If you’ve followed our stock picks long enough, you may have noticed we wantonly throw preferred stocks in the mix with no consideration as to the difference between Preferred and Common. This week’s picks were in fact specifically aimed at -P stocks. But why?

Well, largely because I just learned a new thing and it’s like a kid getting a new toy.

Preferred stock increases security of your investment, and potentially profit.

When a company pays a dividend, it pays to Preferred shareholders before it pays to Common. When a company goes out of business, it pays back Preferred holders before common. Bond holders come before Preferred, though, so it’s slightly more possible to lose your investment.

From the perspective of a working class Joe or Jill just looking to get some kind of reward for saving their money, Preferred shares are a great way to go. For $25, I get 15 cents a month. $2500 gets me $15 a month. $250,000 would be $1500 a month.

If you were saving up a down payment for a home, and decided to keep waiting, then $250,000 might not seem very far away. That could be $150 a month. Not exactly a paycheck, but certainly a phone bill.

The dividend tends to be more stable than holding shares of common stock. This can work against you during times of high volatility. We don’t worry about that. Around here we focus on whether or not we’re happy with our investment as is, not as it could be.

So now that we have the most understanding required to benefit from Preferred stock, let’s look at diagrams and learn some details.

Well I don’t think our 100 shares worth of votes is going to make a difference in anyone’s life. Still, this can be important to think about early on if you intend to invest heavily in a specific company. Buying enough shares to influence a company is a very real and achievable thing.

We covered liquidation briefly already. Dividend preference is the same thing. Preferred gets paid first, if at all. But wtf is par value?

This is confusing as a novice, because we thought the value was what we paid for it. Remember that stock certificates used to be a thing. (Still are, but it’s like $15 to get a certificate printed and mailed). Liken that share now to say, a treasury bond certificate. That bond’s value is $100. Like stock, though, bonds can be traded and its value on an exchange might be more or less than $100. Par value is the value of the share at time of issuance. Market value is what it trades at.

Example, you buy a stock for $28 that has a par value of $25. $28 is the market value. The par value would matter if the shares were to be redeemed at some point. Okay so here’s some copy/paste from a better website.

Par value is the nominal or face value of a bond, share of stock, or coupon as indicated on a bond or stock certificate.

Okay I got it pretty much right.

Back to dividend preference. What happens if a company can’t or won’t pay a dividend this quarter? You might think that’s exactly what happened, you didn’t get your payout. This is not necessarily the case! Even if it is, sometimes a special dividend is issues to compensate for the missed payment. Not always.

Regarding specifically Preferred Stock, there is Cumulative and Non-Cumulative. Non-Cumulative means if you don’t get paid, you don’t get paid. Whatever happens after that, who knows, but you can just not get that quarter’s payment. Ever. It happens.

Cumulative means that you will eventually get all of your dividend payments. So for some reason if you haven’t gotten a monthly payout in 9 months, you can expect to get 9 months’ worth of dividend income. Eventually.

So what does Redeemable mean? Same as Callable. Where bonds are called prior to maturity, Preferred Stock is called after a call date. So if a stock comes callable next month, and the market value is greater than the par value + 1 month dividend, then you should maybe not buy it. Now enjoy a graphic that should help understanding what’s going on.

Coupon is what the issuing company pays on the par value, which for these is all $25. The price shown is the market price. The company paid the same dividend, but your % return probably differs. You bought the stock at $27. Let’s pretend an 8 coupon value (because that’s the example I found on Yahoo!). That $2 you get over the year is a smaller percent of the $27 you paid for a share.

Typically you can expect to have your shares redeemed at some point after the call date. Basically you want to make sure that interest received covers any amount over $25 you paid per share. This matters less if you intend to trade these shares and take profit that way.

Alright, so what is Series? Is that like Class? What is Class?

Series differs between common and preferred stock, and I assume is different from bonds. I’ve just been winging it on bonds with very limited knowledge. So for Preferred…

So I’ve been trying to find information on this for about an hour. It’s not going well. Mostly I get information about VC investing. Series plays a great deal of significance when it comes to funding new companies. Which has nothing to do with Preferred Stock series.

Okay so maybe it does. From what I’m understanding, if I am understanding, is that for newer companies the various series letters have significant weight in their different characteristics.

Since a company can “renumber” rounds of investment, there is no real difference other than price when it comes to well established companies. In the case of liquidation, Series A is paid before Series B. In theory there can be other distinctions, but I haven’t seen any specific examples in my limited research.

What is Class? Here’s a picture followed by information copied from a better website.

The corporation’s owners can create the number and nature of share classes in almost any manner they see fit. Corporate charters – not the law or the courts – define the difference between the classes of stock, often designated as Class A, B and C.

When a company issues Class A and Class B shares of stock, it can define these shares almost entirely as it pleases. It can give Class B shares three votes each, or it can say that Class A stock receives half the dividend access of Class B. So long as the definitions do not violate a shareholder’s legal rights, the company can set these terms as it pleases.

We certainly spread ourselves a bit wide here. Let’s look at another picture, then do a word review of our new terms, and maybe one or two that haven’t yet been mentioned.

Common Stock - Regular old shares of stock.

Preferred Stock - Trades like a stock, pays dividends like a bond.

Cumulative - All dividends are paid eventually in the event a dividend is missed or skipped.

Perpetual - The money faucet stays on forever.

Callable /Redeemable - Shares can be called after a certain date. You sell them back at par value ($25)

Convertible - Option to convert preferred shares to common stock.

Mandatory Convertible - Traditional convertible bonds allow bondholders the option of converting, while in a mandatory convertible this is required. (On or before a certain date).

*Mandatory isn’t necessarily mandatory, but in most circumstances it would appear that way.

TLDR
Cumulative Perpetual Preferred Stock is an easy way to get that 5-9% Annual return.